Charlie is attempting to raise 200,000 through a mortgage from First Loan Company in order to purchase a house for 290,000. They find the company is willing to lend a standard fixed-rate mortgage at j2=8% for a six year term with an amortization period of 25 years. However, Charlie is uncomfortable with the level of monthly payment this implies. The loan officer suggests him to consider a SAM (Shared Appreciation Mortgage). This loan is available at j2=6% also for a six year term. The loan would be fully amortized over 25 years with level monthly payments. If Charlie takes this option, however he will be obligated to give the First Loan Company 20% of any gain in the property value upon the sale of the house or if not sold at the end of the term. Charlie is unlikely to sell the house during the term. Given all above info,
(a) What is the break-even growth rate of house price which makes SAM financially equal cost to the standard mortgage? (14 marks)
(b) Assume the actual growth of house price is 7% per year. Which mortgage should be financially preferred? Standard or SAM? Explain. (1 mark)
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